Alice Phelan Sullivan Corp. v. United States
381 F.2d 399 (1967)
APS Corp. donated some real
estate (worth about $8.7k) to a charity with the stipulation that it be
used for a religious or educational purpose. APS took deductions on their
taxes for a charitable donation.
At the applicable tax rate,
that saved APS about $1.9k in taxes.
In 1957 (seventeen years
later) the charity decided that they didn't want the real estate so they
gave it back to APS.
When they filed their 1957
taxes, APS did not report the return of the property. The IRS assessed a
The IRS argued that the
$8.7k should be included as gross income, which at APS's current tax rate would result in them having to pay about $4.5k in
APS argued that the recovery
of the property was a nontaxable return of capital (they were just getting back what was theirs
to start with).
See Clark v.
Commissioner (40 B.T.A. 333
APS also argued that the
most the IRS could demand was the amount of the tax benefit they received
when they made the donation ($1.9k).
The Tax Court found for the
IRS. APS appealed.
The Appellate Court affirmed.
The Appellate Court found
that since APS originally got a deduction for giving up the property, they would have to pay taxes on the
recovery of that property.
Basically the return of
capital principle doesn't apply
because APS got a benefit when they gave up the property.
The Court looked to 26
U.S.C. §111 and found that it
requires recovered property to be taxed at the tax rate of the year of
recovery, regardless of what the tax rate was in the year that the
property was donated.
Note that this works both
ways. Under §111 a taxpayer can
benefit if their tax bracket is lower when the money is returned, and is
hurt when their tax bracket is higher when the money is returned (like
what happened to APS).